Spring 2002, Volume V, Issue 2   


Considered Responses
Are Your Calls Qualified Covered Calls?

Qualified covered calls (or QCCs) are useful to taxpayers in many investment situations.  However, the rules defining a "qualified covered call option" are complex, and investors often have difficulty determining which calls meet the definition.

A call constitutes a qualified covered call only if it meets at least three basic conditions.

First, the call's strike price must not be too deep in-the-money, which means that the strike price must be close to the closing price for the stock on the previous day.  The minimum strike price required for QCC status is usually one strike below the stock's previous day's closing price.  In addition, the strike price must be at least 85% of the closing price.

Second, options on the underlying stock must be listed on an options exchange.  The call in question does not need to be listed, but some option on the underlying stock must be listed.

Third, when the investor enters into the call, it must have more than 30 days remaining to expiration but not more than 33 months.



On April 26, 2002, Treasury issued final regulations defining QCCs.

The regulations impose additional strike price rules on calls with terms over twelve months.  They maintain the old rule requiring a minimum strike price relative to the stock's close, but they also mandate that before applying this rule, the investor must first increase the stock's closing price by a non-compounded two percent per quarter.  So if  a stock closed at $40.00 and a call had a twenty-five month term, the investor would first multiply $40.00 by 1.16 (1 + (2% x 8 quarters)), reaching a product of $46.40.  With this "applicable stock price," the minimum strike price required for the call would be $45.00 (rather than $40.00, the pre-regulations minimum strike).  

Under the American Jobs Creation Act of 2004, writing in-the-money calls suspends the holding period required to capture dividends or the DRD.  See Tougher Rules For Hedging Dividends. 

To help investors determine whether their calls are qualified, Twenty-First Securities has created an interactive call assessment program for options acquired on or after July 29, 2002.

This article and other articles are provided for information purposes only.  They are not intended to be an offer to engage in any securities transactions or to provide specific financial, legal or tax advice. Articles may have been rendered partly inaccurate by events that have occurred since publication.  Investors should consult their advisers before acting on any topics discussed herein.

Options involve risk and are not suitable for all investors.  Before engaging in an options transaction, investors must review the booklet "Characteristics and Risks of Standardized Options".  



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